Top Semiconductor Manufacturing Picks by High Alpha Funds Concentrated in the Industry - Part I

Includes: ATML, MU, SWKS, TSM, WDC
by: GuruFundPicks

Leading hedge fund and mutual fund managers that have a long-term track record of generating high market-beating returns are neutral on the semiconductor manufacturing group, adding a net $9 million (including cutting $904 million and adding $913 million) from their $6.73 billion prior quarter position in the group. Overall, they are under-weight the group by a factor of 1.6. That is, taken together, 70+ high alpha or guru funds have invested 1.3% of their assets in the group, significantly less than the 2.1% weighting of the group in the overall market.

However, seven of these guru funds have invested three times that or over 3.9% in the semiconductor manufacturing group. The following is our take on their top picks in the group:

Buy Micron Technology (MU): Micron is a leading manufacturer of semiconductor memory solution, including DRAM, NAND and NOR flash memory, phase change memory, and image sensors. These memory products are used in a range of electronic applications, including personal computers, workstations, network servers, mobile phones, flash memory cards, USB storage devices, digital still cameras, MP3/4 players, and in automotive applications. Guru funds cut a net $104 million from their $542 million prior quarter position in the company, but together they still hold 5.23% of the stock, at four times their weighting in the group.

Micron trades at a forward 9 price-to-earnings ratio (P/E), 0.80 price-to-sales ratio (PSR), and at 0.85 price-to-book ratio (P/B), all near the bottom of their historical ranges. The stock fell recently on account of weak revenue and earnings for the May 2011 quarter, and is currently down almost 40% from its recent high three months ago. However, gross margins improved 300 basis points in the May quarter to 22.3%, and the earnings miss was due to lower revenue and a large one-time tax expense. Furthermore, the company generated a healthy $211 million in cash during the quarter.

We reiterate our previous buy issued on Micron, and believe that it is a good long-term value buy. While fundamentals deteriorated for the most recent quarter, the stock trades at compelling valuations and the forward indicators of demand for the company's products are positive. The Windows 7 upgrade cycle worldwide is likely to propel a rebound in PC demand going forward, which will lead to higher DRAM and NAND memory sales. Moreover, the increasing sales of PCs with multi-core processors will also fuel the demand for more DRAM and NAND flash memory. Furthermore, while consumer PC demand may remain sluggish due to the weak economy, corporate demand for PCs and servers, and the demand for smart phones and tablets that would use the company's chips continue to be positives. We would be buyers ahead of these positive developments, while the stock still trades at a discount. We believe that there is strong upside here to the $12 range, while the downside is limited to $6-7. Analyst mean targets are $12, with a high of $18. Of the 26 analysts that cover the stock, 18 rate it a buy/strong buy, five a hold, and three gave it an underperform rating.

Gurus Bearish on Skyworks Solutions Inc. (SWKS): Skyworks is the industry's leading wireless semiconductor company focused on radio frequency (RF) and semiconductor solutions for mobile communications applications. These RF semiconductors are essential for 3G and 4G platforms, and the company continues to benefit from the ongoing explosive growth in the smart phone market, a trend that is likely to last many years as smart phones gain market share worldwide. Guru funds aggressively cut a net $69 million from their $140 million prior quarter position, and hold 1.5% of the company shares.

Skyworks trades at a 15 P/E on a TTM basis and at a forward 13 P/E, about mid-range based on its historic range. Meanwhile, earnings have increased from 69c in 2009 to $1.26 in 2010 and are projected to increase to $2.12 in 2012 at a 45% compounded growth rate. The company reported its June 2011 quarter report last week on Thursday after-close, beating both revenue and earnings estimates at $356 million and 49c versus estimates of $347 million and 46c, and it guided up September 2011 quarter revenues to $400 million versus the $373 million estimate. We reiterate our previous buy based on that earnings report. And we would still be buyers here as the company trades at an attractive valuation, at a discount to its growth rate, and it operates in a very attractive mobile connectivity industry that is growing explosively.

Gurus Bullish on Atmel Corp. (ATML): Atmel is a manufacturer of micro-controllers, application-specific ICs, non-volatile memory and RF components. The company has been instrumental in developing and commercializing nonvolatile memory or memory that continues to store information after power is turned off. Guru funds are bullish on Atmel and together hold 7.8% of the stock, and six times their weighting in the group. They added a net $13 million to their $475 million prior quarter position in the group. Atmel trades at a forward 13 P/E, while revenues are projected to increase at 20% compounded growth rate, and earnings are projected to increase at 26% compounded growth rate from 60c in 2010 to 95c in 2012. Analyst mean targets are $17, with a high of $22, above the current $12 price. Of the 16 analysts that cover the company, 14 rate it at buy/strong buy and two rate it at hold.

Gurus Bearish on Sandisk Corp. (SNDK): Sandisk manufactures non-volatile or flash removable memory cards used in a number of rapidly growing consumer electronics products such as smart phones, personal digital assistants, digital cameras, portable digital music players, digital video recorders, gaming devices and computers. Guru funds cut a net $104 million from their $198 million prior quarter position in the company, and together they hold only 0.9% of the shares. Sandisk trades at a forward 9 P/E, while earnings are projected to be almost flat, rising from $4.60 in 2010 to $4.63 in 2012. Analyst mean targets are $59, well above the current $42 price. Of the 21 analysts that currently cover the company, 17 rate it at buy/strong buy, two at hold, and two rate it at underperform.

Buy Taiwan Semiconductor ADR or TSMC (TSM): Taiwan Semiconductor is the world's largest dedicated IC foundry manufacturing logic and mixed-signal ICs for fabless semiconductor companies and integrated device manufacturers. As a foundry, Taiwan Semiconductor uses its advanced manufacturing processes to manufacture ICs for its customers based on their proprietary IC designs. Gurus added a net $17 million to their $62 million prior quarter position in the company.

Taiwan Semiconductor trades at a forward P/E of 11-12, in the bottom third of its historic P/E range, and at a discount to its regional rivals: Taiwanese foundry United Microelectronics ADR (UMC) that trades at 22 forward P/E and Chinese foundry Semiconductor Manufacturing International ADR (SMI) that trades at 38 forward P/E. Taiwan Semiconductor also sports a handsome dividend yield of 6.3%. Competitor United Microelectronics has a 6% dividend yield and Semiconductor Manufacturing International has no dividends.

Revenue and earnings at Taiwan Semiconductor have trended up every year since bottoming at $3.6 billion and 10c in 2001, while the stock has traded range-bound between $6 and $12 during that period.

Technically, the stock has formed a great 10-year long-term base and has been consolidating in a tight range between $11 and $14 since the beginning of the year. As the global recovery takes hold, Taiwan Semiconductor being the world's leading foundry will benefit from increasing sales. Furthermore, there have been reports that tech juggernaut Apple, Inc. (AAPL) may cut ties with Samsung (OTC:SSNLF) and is in talks with Taiwan Semiconductor to outsource manufacturing of its A6 processors.

We believe that Taiwan Semiconductor fundamentals maybe coalescing for the stock to break out of its long-term trading range and mount an upward rally. We first recommended a buy on Taiwan Semiconductor on July 14th, and we still think it is a good buy at today’s prices.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Credit: Historical fundamentals including operating metrics and stock ownership information were derived using SEC filings data, I-Metrix® by Edgar Online®, Zacks Investment Research, Thomson Reuters and The information and data is believed to be accurate, but no guarantees or representations are made.

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